Fueling a New Wave of Responsible PE Investments

LeadershipEnvironmental, Social, and GovernancePrivate CapitalSustainability
Article Icon Article
Jane Xing
April 08, 2022
3 min read
LeadershipEnvironmental, Social, and GovernancePrivate CapitalSustainability
Executive Summary
PE firms operating in China who align their investment strategies to national priorities, and market trends, will reap the biggest returns in the years ahead.
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How China’s current regulatory environment is fueling a new wave of responsible PE Investments.

In the past year, China has enacted a series of regulatory changes designed to develop a modern socialist economy. The government is moving rapidly to reach its strategic social and political goals outlined in its 14th Five-Year Plan for 2021-2025, which focus on China’s “vast domestic market and bolster its economic self-reliance as it faces an increasingly challenging external environment.” 

In the wake of its publication, countless media outlets spoke of “regulatory assaults” and “crackdowns,” warning that the new rules would disrupt PE investment strategies and the flow of capital across the country. Yet six months on, it is clear that there is no need to panic. 

As any PE firm operating in China knows, navigating the ever-changing regulatory environment comes with the territory. The updates will create both winners and losers—but those who continue to align their investment strategies to national priorities, as well as market trends, will be the ones that reap the biggest returns in the years ahead. While we may start to see some rationalization, the market for capital in China still remains hot. 

Changing regulations shift PE investment priorities

One of the sectors that has been hit hardest by changing regulations is big tech. Tightening rules over the past year are expected to cost companies such as Alibaba, SoftBank, as well as investors, billions of dollars. In July, the country banned private tutors from providing instruction online, another industry that benefitted from massive capital infusions from PE firms. In August 2021, a rule restricting those 18 and under from playing video games for more than three hours a week is also hitting the gaming industry hard. 

“The speed of the reforms means that companies in fields from fintech-lending and e-commerce to self-driving cars, social media and video-gaming must rethink how they make money and handle data,” The Economist recently reported.

As companies in sectors hard hit by regulation continue to pivot, new opportunities are emerging elsewhere for PE investors. From biotech and renewable energy to artificial intelligence (AI) and electric vehicles, PE firms investing in China are eyeing industries that will meet the country’s determination to be less reliant on outside resources and reach its commitment to net-zero emissions by 2060.  

Managing regulatory expectations in these industries will continue to be a priority for PE firms operating in China. Expertise is required to stay on top of changing and challenging regulations, especially as firms seek to understand the risks and challenges associated with compliance while maintaining business goals and objectives.

Adding to the new PE Equation:  Meeting ESG Standards

Adoption of ESG principles is already widespread in China. Voluntary disclosure of ESG data by Shanghai-Shenzhen CSI 300 Index companies nearly doubled from 2009 to 2021 to reach 83% Yet it is widely expected that the changing regulatory framework will further accelerate China’s transition to sustainable business practices. 

The recent 14th Five Year Plan set out steps to accelerate the shift towards a low-carbon economy and achieve carbon neutrality by 2060, as well as goals to safeguard natural ecosystems and biodiversity. With this, attention is turning to the role private and public companies can play in helping to build a more sustainable and resilient future for all. 

This growing commitment to integrating ESG goals into business practices creates new considerations for PE firms as they look to build organizations that can successfully meet the growth and demand for this new accountability. 

Identifying PE leaders who bring ESG knowledge and expertise will be a first step in creating a culture and fostering frameworks for new investment opportunities. While many firms may think about bringing in leadership from overseas, identifying talent locally with specific knowledge of the market, regulations and ESG-related activities can provide an advantage. This will only become more important as the Chinese PE landscape continues to evolve rapidly and the pace of innovation accelerates.